Ans. i. ACCOUNTING EQUATION
The recording of transactions in the books of accounts is based on accounting equation. Each transaction has double effect on the financial profit of a concern. Accounting equation is a formula expressing equivalence of the two expressions of assets and liabilities. Thus, the total claims will equal to the total assets of the firm. The total claims may be to outsiders and the proprietor. In the beginning the owner of the firm provides funds to the business in the form of ‘capital’ which is also known as ‘owners equity’. Initially the capital contributed by the owner to the business will be in the form of cash and this cash is treated as an asset of the firm. At the same time a liability will be created in the form of owners’ equity according to business entity concept (i.e., business and the owner are two separate entities). Thus, the asset is (cash) balanced against liability (capital).
The accounting equation can thus be expressed as follows :
Cash (Asset) = Capital (Liabilities)
Total Assets = Total Liabilities (Capital + Liabilities)
OR
Fixed Assets + Current Assets = Internal Liabilities + External Liabilities
Capital = Assets – Liabilities
OR
Liabilities = Assets – Capital
Thus the above relationship is known as accounting equation and it is also called as Balance Sheet equation. Each transaction will affect the above equation but the relationship will remain the same on account of dual aspect of the transaction. An increase in asset side leads to increase in the liabilities side and vice versa. Thus dual effect will take place either on the same side or on both the sides of accounting equation.
ii. ACCOUNTING
STANDARDS
An Overview Accounting standards are generally accepted accounting principles which provides the basis for accounting policies and for preparation of financial statements. The object of these standards is to provide a uniformity in financial reporting and to ensure consistency and comparability of the information provided by the business firms. Therefore, the standards set for must be easily understandable as well as acceptable by all and significantly reduce manipulation of information in the books of accounts. Thus, accounting standards provide useful information to the users to interpret published reports. It provides information about the basis on which accounts have been provided and the rules followed while preparing financial statements.
Importance of
Accounting Standards
1) It helps the investors in assessing the return and possible risk involved in evaluating the various investment proposals in different enterprises.
2) It raises the standards of audit while reporting the financial statements to the management.
3) It helps the government and other interested parties in formulating economic policies, tax planning, market analysis, investment decisions etc.
4) It helps the Chartered Accountants to deal with their client, in preparing financial statements on a true and fair basis. They can refuse the reports of their clients which are found to be incorrect or misleading.
5) It helps the interested parities to understand the information properly and make meaningful comparisons and interpretations for decision-making purposes.
6) It facilitates inter firm comparison of the financial position and operating results of similar enterprises.
7) It will reduce the scope of manipulation of accounts to suit the requirement of management.
8) It would facilitate the development of international trade and commerce as financial statements are clearly understandable.
iii. FINANCIAL ACCOUNTING PROCESS
Accounting may be defined as the process of recording, classifying, summarizing, analysing, and interpreting the financial transactions and communicating the results thereof to the persons interested in such information. Thus the accounting process consists of the following five stages :
1) Recording the Transactions,
2) Classifying the Transactions,
3) Summarizing the Transactions, and
4) Interpreting the Tesults.
Let us discuss
briefly these stages:
1) Recording the Transactions : The accounting process begins with the basic function of recording all the transactions in the book of original entry. This book is called ‘Journal’. The journal is a daily record of business transactions. All business transactions of financial character are recorded in the journal in a chronological order (date wise) with the help of various vouchers such as cash memos, cash receipts, invoices, etc. The process of recording a transaction in the journal is called journalising. The journal may be further sub-divided into various subsidiary books such as cash journal for recording cash transactions, Purchase Journal for recording purchase of goods, Sales Journal for recoding sale of goods, etc. The number of subsidiary books to be maintained will depend upon the nature and size of the business.
2) Classifying the Transactions : The journal is just a chronological record of all business transactions and it does not provide all information regarding a particular item at one place. To overcome this difficulty we maintain another book called ‘Ledger’. It consists of systematic analysis of the recorded data with a view to group the transactions of similar nature and posting them to the concerned accounts. It contains different pages of individual account heads under which all financial transactions of similar nature are collected. For example, all transactions related to cash are posted to cash account and transactions related to different persons are entered separately in the account of each person. The objective of classifying the transaction in this manner is to ascertain the combined effect of all transactions of a given period in respect of each account. For this purpose all accounts are balanced periodically.
3) Summarising the Transactions : The third step is presenting the classified data in a manner which is understandable and useful to the internal as well as external end users of accounting information. This can be done through the preparation of a year end summary known as ‘Final Accounts’. Before proceeding to final accounts one has to prepare a statement called ‘Trial Balance’ in order to check the arithmetical accuracy of the books of accounts. If the Trial Balance tallies, more or less it means that the transactions have been accurately recorded and posted into the ledgers. Then with the help of the Trial Balance and some other additional information, final accounts are prepared. The objective of preparing final accounts are :
i) To know the net operating results of the business, and
ii) To ascertain the financial position of the business at a particular date.
The operating results of the business can be ascertained by preparing an income statement called Trading and Profit and Loss Account and financial position of the business can be known by preparing a position statement called ‘Balance Sheet’. The Trading and Profit and Loss account gives information about the profit or loss made during the year and the Balance Sheet shows the position of assets and liabilities of the business at a particular time.
4) Interpreting the Results : The final stage of accounting is analysing and interpreting the results shown by the final accounts. The recorded financial data is analysed and interpreted in a manner that the end users can make a meaningful judgement about the financial position and profitability of the business operations. This involves computation of various accounting ratios to assess the liquidity, solvency and profitability of the business. The balance on various accounts appearing in the Balance Sheet will then be transferred to the new books of account for the next year. Thereafter the process of recording transactions for the next year starts again.
The accounting information after being meaningfully analysed and interpreted has to be communicated in the proper form and manner to the proper person. This is done through preparation and distribution of accounting reports which includes besides the final accounts, in the form of ratios, graphs, diagrams, funds flow statements, etc.
iv. BRANCHES OF ACCOUNTING
To meet the requirements of different people interested in accounting information, accounting can be broadly classified into three categories :
1) Financial Accounting,
2) Cost Accounting, and
3) Management Accounting
1. Financial Accounting The American Institute of Certified Public Accountants has defined Financial Accounting as “the art of recording, classifying and summarizing in a significant manner in terms of money transactions and events which are in part at least of a financial character, and interpreting the results thereof”. Accounting is the language effectively employed to communicate the financial information of a business unit of various parities interested in its progress.
The object of financial accounting is to find out the profitability and to provide information about the financial position of the concern. Two important statements of financial accounting are Income and Expenditure Statement and Balance Sheet. All revenue transactions relating to a particular period are recorded in this statement to decide the profitability of the concern. The balance sheet is prepared at a particular date to determine the financial position of the concern.
2. Cost Accounting
Cost accounting is one of the important elements of accounting information about the problems of internal managerial control. Financial accounts are unable to meet information needs about the cost structure of a product. The need for cost determination and controls necessitated new set of principles of accounting and thus emerged ‘Cost accounting’ as a specialised branch of accounting. Cost accounting is the process of accounting for costs. It includes the accounting procedures relating to recording of all income and expenditure and preparation of periodical statements and report with the object of ascertaining and controlling costs. Such cost accounting is a good technique for ascertaining profitability and for decision making. The Institute of Cost and Management, London defines cost accounting as “the application of costing and costing principles, methods and techniques to the science, art and practice of cost control and ascertainment of profitability. It includes presentation of information derived there from for the purpose of managerial decision making.”
3. Management Accounting
Cost accounting helps the internal management by directing their attention on inefficient operations and assisting in a day-to-day control of business activities. The costing data needs to be arranged, re-analysed and processed further for effective role in managerial process. In addition to costing and accounting data, managerial functions need the use of socio-economic and statistical data (e.g., population break-ups, income structure, etc.). Cost and financial accounting do not provide such information and this limitation pave the way for the emergence of management accounting. Management accounting is a systematic approach to planning and control functions of management. It generates information for establishing plans and controls. It provides for a system of setting standards, plans, or targets and reporting variances between planned and actual performances for corrective actions. Thus, Management accounting consists of cost accounting, budgetory control, inventory control, statistical methods, internal auditing and reporting. It also covers financial accounting.
No comments:
Post a Comment